Knowledge that Transforms

One of the important determinants of fertility is the value of children as perceived by parents. This paper estimates gender- and age-specific values of children using a dynamic programming model. Findings from the Korean data indicate that children impose net costs when young and net benefits when old. Both the early costs and the later benefits are larger for male children than female children, and for better-educated women than lower-educated women. Simulation studies that use estimated values of children suggest that a decrease in the costs of abortion and prenatal gender-screening tests may raise the male-birth ratio through gender-selective abortions. Copyright 1995 by The Review of Economic Studies Limited.

This paper considers a representative agent model of asset prices based on a recursive utility specification. A constant elasticity of intertemporal substitution is assumed but the risk-preference component of utility is restricted only by qualitative, non-parametric regularity conditions. A principal contribution is to determine the exhaustive implications of this semiparametric recursive utility model for the one-step ahead joint probability distribution for consumption growth and asset returns. It is also shown, in contrast to the claims of previous studies, that the generalization from expected utility to recursive utility contributes substantially to the resolution of the equity premium puzzle.

The aggregate rate of R&D in a competitive economy is compared with the optimal rate. The optimal rate of R&D is shown to be the same for all preferences in a broad family, while the competitive rate is sensitive to the form of substitutability among products and so can vary dramatically within a family. The second-best level of R&D is shown to be also common within a family and equal to the optimal rate. Numerical examples suggest that diminishing returns in the innovation technology is the most important potential source for excessive R&D in a competitive economy.

Within a hierarchical firm structure, this paper details how the composition of a worker's skills and the non-observability of a worker's ability affect wage and promotion paths. Promotion-based compensation schemes derive naturally from the worker's asymmetrically observed ability. Promotion takes place over time and is inefficient since employers strategically exploit their knowledge of an able worker's ability. Conversely, employers may be unable to efficiently demote and retain bad managers without paying bonuses. Employers are led to promote educated employees before their equally or more able, but uneducated, counterparts. Explanations for fast-track promotions plans, and other empirical regularities are provided.

When sustained growth depends on establishing an indivisible infrastructure for directly productive activities (DPAs) both discrete and marginal departures from optimal growth can undermine the dynamic efficiency of the market. Producers' anticipations of paying monopoly fees for infrastructure services dampen their incentive to invest in DPAs and may prevent the economy from reaching a minimal level of activity that would justify investment in a large indivisible infrastructure; and potential investors in infrastructure may be intimidated by the prospect of expropriatory regulation. Thus a credible prior commitment to effective but fair regulation is necessary for achieving optimal growth. But it may not be sufficient. Low-level expectations before the infrastructure is established can be self-fulfilling, indicating a role for coordinative industrial policy. Investment subsidies, even in conjunction with regulation, cannot induce an efficient equilibrium.

We investigate the structure of competitive equilibria in an exchange economy parametrized by (i) endowments and (ii) restrictions on market participation. For arbitrary regular endowments, if few consumers are restricted, there are no sunspot equilibria. If endowments are allowed to vary, while restrictions on market participation are fixed, there is a generic set of preferences such that sunspot equilibria exist for a non-empty subset of endowments. Our analysis extends to the general case of an arbitrary number of restricted consumers the results of Cass and Shell for the polar cases in which either (i) no consumers are restricted or (ii) all consumers are restricted.

This paper examines how the possibility of recontracting affects the financing of projects when an entrepreneur is privately informed about the distribution of returns. An entrepreneur solicits initial financing for a project from competing uninformed financiers. Once the project is undertaken, but before its returns are realized, the entrepreneur can solicit additional financial contracts from competing financiers. It is assumed that these financiers can observe all previously signed contracts and that the seniority of claims is respected in the case of bankruptcy; however, the entrepreneur is never committed not to sell junior claims to competing financiers. Copyright 1995 by The Review of Economic Studies Limited.

This paper considers an alternative asymptotic framework to standard sequential asymptotics for nonlinear models with deterministically trending variables. The asymptotic distributions of generalized method of moments estimators and corresponding test statistics are derived using this framework. The asymptotic distributions are shown to be the same with deterministically trending variables as with non-trending variables. That is, the distributions are normal and chi-squared respectively. The asymptotic covariance matrices of the estimators, however, are found to depend on the form of the trends. These findings provide a justification for the use of standard asymptotic approximations in nonlinear models even when the variables have deterministic trends.

This paper studies a dynamic insurance problem with bilateral asymmetric information and balanced budgets. There are two infinitely-lived agents in our model, both risk averse, and each has an i.i.d. random endowment stream which is unobservable to the other. In each period, each agent must have a non-negative consumption and together they must consume the entire aggregate endowment. Dynamic incentive compatibility in the Nash sense is defined. We give sufficient and necessary conditions for the existence of a constrained efficient contract. We show that a constrained efficient contract can be characterized in a Bellman equation. We demonstrate that the long-run distribution of expected utilities of each agent is not degenerate. We also develop an algorithm for computing the efficient contract and, in a numerical example, we find that the consumption processes of the agents form stationary Markov chains.

This paper provides a model of firm and industry dynamics that allows for entry, exit and firm-specific uncertainty generating variability in the fortunes of firms. It focuses on the impact of uncertainty arising from investment in research and exploration-type processes. It analyses the behaviour of individual firms exploring profit opportunities in an evolving market place and derives optimal policies, including exit, in this environment. Then it adds an entry process and aggregates the optimal behaviour of all firms, including potential entrants, into a rational expectations, Markov-perfect industry equilibrium, and proves ergodicity of the equilibrium process. Numerical examples are used to illustrate the more detailed characteristics of the stochastic process generating industry structures that result from this equilibrium.